A Bitcoin Multisig Primer: How Does it Work & What You Need To Know
Bitcoin (BTC) multisig wallets provide an added layer of security for large bitcoin holders as they require more than one person to sign a transaction.
In this article, we will explore what multisig BTC wallets are, how they work, and discuss their most pressing pros and cons.
Multisig stands for Multi-Signature. It is a type of digital signature scheme where a group of users can authenticate a single document. The signature produced in the multisig scheme is typically smaller than a collection of single signatures. This feature makes it a space-efficient scheme.
Multisig capabilities were added to the Bitcoin blockchain in 2012. The first multisig wallets created for the end-user came to the market in 2013. Prior to that, the standard for personal users was the single key address.
In the single key address scheme, Alice holds both her public and private keys. She uses her private key to authenticate transactions. The private key gives her complete control of the bitcoin held in the address. While this setup is efficient at maintaining control, it does come with the major drawback of having a single point of failure.
For personal and business users alike, single key addresses may prove to be catastrophic if they lose their wallet password and/or seed phrase. While most will ensure to store the mnemonic phrase with great care, it is possible to lose access to it. For example, Alice may use a paper wallet. However, she finds that her paper wallet has become illegible or lost and she loses access to her coins.
Alternatively, a business, say a custodial bitcoin exchange, may hold its customers’ bitcoin in a single key address. This scenario means that either a single party has control over the funds or that many parties are privy to the private key. Either scenario is unfavorable as it introduces security risks.
Bitcoin multisig capabilities help to manage these challenges as it allows more than one party to authenticate transactions. In the context of Bitcoin, the funds held in a multisig address can be transferred only if the required signatory threshold is met.
There are different variations of multisig addresses. Examples include 2 of 2 where two signatures out of a total of two must sign a transaction. Or 2 of 3, or 3 of 4 and etc. The signatures in a multisig address are all generated by a different private key.
For instance, Alice has a wallet she shares with her wife Jane, which they use as a savings account. They can create a 2 of 2 multisig wallet that they must each sign with their own private key to move any of their bitcoin holdings. Alternatively, they may create a 2 of 4 multisig address, where their two children can also sign the transactions.
How to use multisig
Leveraging multisig for personal use is relatively simple to do. There are several wallets that support this capability, allowing you to customize the number of signatories and the required threshold to make transactions.
Bitcoin wallets that have enabled multisig capabilities include but are not limited to:
To create and use a multisig wallet, choose from one of the above or other wallets, and download the software from the official website.
Once installed, the software will ask you to create a wallet. At that juncture, you can pick between a single key address or a multisig. Choose multisig and follow the instructions until the end.
All parties will be required to write down, or otherwise carefully store, the seed phrase as is ubiquitous in single key addresses.
And that’s it. While the exact step-by-step process differs slightly from wallet to wallet, it should not take more than these steps to set up multisig.
Pros & Cons of Bitcoin multisig wallets
Multisig wallets come with a number of advantages.
The first of these is enhanced security. They help mitigate fund recovery challenges related to loss or theft of the single private key. For instance, Alice and Jane can still access their savings if Alice loses her private key, provided one of their children can sign the transaction. Additionally, multisig wallets can be leveraged as a type of 2FA for Bitcoin, even for a single user. This enhances security and avoids loss of funds through malicious activity.
Secondly, multisig addresses support the creation of escrow transactions. Alice and Jane can create a multisig address that they use to store funds but can add a trusted third party that will act as a mediator in the event of disputes. A 2 of 3 wallet is ideal for this scenario. However, as aforementioned multisig addresses can be designed with specific needs in mind.
A third advantage of multisig wallets is to support decentralized decision-making. This is especially important for businesses that hold funds in bitcoin. Using a multisig address reduces the chances of a single party misappropriating funds. Additionally, it also ensures accountability and communication as the minimum threshold must be met before any funds are moved.
The disadvantages of using multisig addresses are complexity and legal recognition. Some users may find setting up a multisig address to be too difficult.
Legally, it is difficult to prove ownership of funds held in a multisig address. Due to this, it may be hard to find legal recourse in the event of any issues. This is an important point to consider.
Depending on your specific needs and the level of complexity you are willing to deal with a multisig address may work well for you. For BTC businesses or large investors, a professionally managed multisig wallet setup should be a standard.
However, as a small investor, if you currently use a single key address and are satisfied, there is likely no need to make the switch.
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